Can contracting parties flow down obligations from other agreements, even when that means compelling arbitration?

A recent decision from the Nebraska Supreme Court1 illustrates the interplay of two key construction contract provisions, flow-down clauses and arbitration provisions, and throws in a dose of contract interpretation for good measure. The upshot: arbitration continues to be common in construction disputes, and courts will enforce a subcontract requirement that a subcontractor arbitrate its claims, even when the requirement flows down from an upstream contract.

Basic facts of the case: under the terms of the general contract to build several structures, the owner (Grossenburg) and general contractor (Kiehm) agreed to resolve their disputes by arbitration. Kiehm’s subcontract with its electrical subcontractor, Frohberg, contained several provisions that purported to bind Frohberg to the general contract. (These are commonly called “flow-down clauses.”) One clause referenced the existence of the general contract and another stated that Frohberg agreed to be bound to Kiehm by the terms of the general contract. The subcontract also contained a section that began, “The Contractor agrees,” and detailed several covenants, one of which stated, “If arbitration of disputes is provided for in the General Contract, any dispute arising between…Contractor and…Subcontractor under this Subcontract, including the breach thereof, shall be settled by arbitration in the manner provided for in the General Contract.”

Kiehm and Frohberg had a dispute about payment, leading Frohberg to file a mechanic’s lien and a lien foreclosure lawsuit. Grossenburg and Kiehm asked the district court to stay the litigation and require all three parties to arbitrate, which the court declined to do. The district court concluded the subcontract did not bind Frohberg to arbitrate when it was the party initiating the claims because only Kiehm had bound itself to arbitrate (“Contractor agrees…”). The district court also concluded that the other flow-down language was too vague to show Frohberg had bound itself to arbitrate its own claims or disputes involving the owner.

On review, the Nebraska Supreme Court reversed. It found that the district court’s interpretation of the subcontract’s agreement to arbitrate mistakenly focused on the “Contractor agrees” language to the exclusion of language in the covenant itself that showed that both parties had expressed an intent to arbitrate. The Supreme Court focused on the “agreement” that was expressed and concluded that an agreement to arbitrate only made sense if it was between both parties.

The Grossenburg case underscores the importance for general contractors to include well-drafted flow-down clauses in their subcontracts to ensure that subcontractors are properly bound to the terms of the prime agreement. Here the Nebraska Supreme Court’s common sense interpretation of the subcontract saved Kiehm from having to litigate with its subcontractor while arbitrating with the owner, as well as the expense of two proceedings. But the decision avoided an additional problem—potentially inconsistent holdings between Kiehm’s arbitration with Grossenburg and Kiehm’s lawsuit with Frohberg. From the standpoint of subcontractors, a well-drafted flow-down clause provides important clarity as to the responsibilities the sub is assuming.

Grossenburg illustrates the importance for all parties in the construction process to address up front a disputes process that makes sense for a particular project. Whether arbitration or litigation, which parties will be required or permitted to participate? What happens if there are pass-through claims of subcontractors (i.e., claims the owner is responsible for) and claims that are only between the general contractor and a subcontractor? These are some of the many issues that should be considered in laying out the scope of a disputes clause, and the key is to thoughtfully consider the issue up front to ensure there is a fair process for all affected parties.

Finally, the Grossenburg decision also illustrates an everyday problem in construction contracting: how to interpret ambiguous contract language. The Supreme Court’s opinion employed several bedrock tools that are usually in play with contract interpretation problems.  First, it considered all pertinent parts of the contract and harmonized them to find the parties’ intention. Second, it showed that even if an argument can be made in favor of an interpretation, a court will not accept the interpretation if it is not reasonable, especially when the suggested interpretation ignores other, relevant language. These tools are available for interpreting any ambiguous contract language, and parties should consider them when reviewing potential interpretations of contract language.

If you have any questions or need assistance, please contact one of Woods Aitken’s Construction Attorneys. For additional construction news, tips, and updates, we encourage you to view our Construction E-Brief archives.

1Frohberg Elec. Co., Inc. v. Grossenburg, Implement, Inc., 297 Neb 356, __ N.W.2d __ (2017).